“ACCREDITED INVESTOR” – THE OFFICIALLY WEALTHY WHO YOU NEED TO SOLICIT FOR FINANCING

The “accredited investors” as defined by the new SEC ruling allowing for general solicitation, are officially wealthy, and are accustomed to dealing with basic financial reports and terms.

THE HIGH RISK OF INVESTING IN FILM

Mr. Bucks has heard about the high risk of the film business. You will need to create the confidence with Mr. Bucks that you CAN produce – at a return. So, now, more than ever before, it behooves Indie film producers to understand the basics of the film industry as a business – especially if he/she wants to solicit the officially wealthy who don’t know film.

THE BUSINESS LANGUAGE OF FILM

For those of you who do learn the Business Language of the film industry you will find that doors previously closed to you will open – just a crack , at first, but with some perseverance the Completion Guarantors, experienced Directors and Cinematographers, some Mini-Major Studios, etc. will be impressed and will offer more and more opportunities. Success breeds success, and it starts with generating confidence.

CREATING CONFIDENCE THAT YOU ARE FISCALLY RESPONSIBLE

From my point of view (30 years in the ‘biz) there are 5 or 6 things you should learn more about, and with a little practice, you will have a very good shot at creating the confidence needed by the investor that you are fiscally responsible. You really can’t lose. In my book, “Walk The Talk” I refer to it as “Directing the Money”.

Crowdfunding always seemed like a “wank” to me until I started to look into the new SEC Rulings from July – 2013. (They’re taking effect in mid-Sept – 2013). Really, I had the idea that Crowdfunding was an effort by a bunch of Indie wanna-be’s whining to raise funds without making the effort to understand the Business of Film.

Maybe it was a hope and a wish before, but now it’s about to go open up Indie financing in previously unknown ways.

CROWDFUNDING IS ACTUALLY AN OFFER TO SELL SECURITIES

The Crowdfunding process is actually making “an offer to sell securities”, so it falls into the sacred territory of Hedge Funds. The people who invest will own a few points in your film – the number of points will be proportional to the amount of money invested – this is the same principle as Hedge Funds, and, indeed, is regulated by the same Regulation D of the Securities Act.

THE DIRTY THIRTIES

Many moons ago, right in the middle of the “dirty thirties” following the terrible market crash in October, 1929, the US Securities & Exchange Commission passed a ruling saying that you must register every offer to sell securities. At that time they left a loop-hole – Regulation D – a list of “Rules” for small businesses who couldn’t afford all the red tape involved with this registering process. The Rules are numbered 501 through to 508, so you may see terms like “Reg D, Rule 506”, etc. The rules are meant to be protective of the integrity of non-registered sales of securities and are restrictive.

THE JOBS ACT – SECTION 181, AND NOW RULE 506 (C)

The Jobs Act, which is the legislation behind the Federal Film Tax Incentives (generally referred to as “Section 181”) encourages investment in small business by easing certain securities regulations. As part of the general compliance with the Jobs Act, in July 2013 the SEC passed Rule 506 (c) ) to allow general solicitation and advertising for a private placement offering. However, in a Rule 506(c) private offering all of the purchasers must be accredited investors and the issuer must take reasonable steps to determine that the purchaser is an accredited investor. The SEC legislation can be downloaded by clicking here http://www.sec.gov/rules/proposed/2013/33-9416.pdf

The most interesting to me is #7: “a natural person with income exceeding $200,000 in each of the two most recent years or joint income with a spouse exceeding $300,000 for those years and a reasonable expectation of the same income level in the current year”.

WHAT DOES THAT MEAN TO THE INDIE PRODUCER?

I think an article by Carl Brown in “Slated” on July 19, 2013 says it best:

“ … even if the SEC’s final rules don’t end up inducing millions more private investors overnight into the film industry, they will still spur the need for more diligent background checks, not to mention private placement memos that are grounded in more realistic and informed financial projections. The demand for better film data and verification paperwork will increase, and so too the likelihood that this industry will win acceptance and long-term legitimacy among a wider pool of accredited investors”.

IN SUMMARY

You will see a field of investors opening up which had been blind to us all before; however, it will also raise the bar on the quality of proposals required by the Indie Producer. Yes, the creative idea will still have power, but there will be a very high expectation from “Accredited Investors” that the Indie Producer is competent to handle their money. Your challenge will be to generate that confidence by demonstrating that you understand finance.

Someone sent me an interesting Section 181 question on LinkedIn. I thought I’d share the question and the answer her. (She has a project which can be shot inexpensively in the Czech Republic with only minor parts shot in the USA – the project would be using US cast, and many US crew while shooting in the Czech Republic – who would be taxed at home; so her question makes some sense.)

QUESTION:

Dear John,

I am taking the liberty to ask you a question regarding the section
181. Some websites say that 75% must be “shot” in US, others say that
75% of the budget must be “spent” in US. If the tax is based on budget
expenses then our production will qualify. Please be so kind and help
me to clear up my confusion. I don’t want to give wrong information to
the investors while raising funds.

__________________________________________________________

MY ANSWER:

Hi, MarieAnna. I have finally found the time to dig into Section 181 to answer your question. Again, I am not an expert in these matters, so please don’t depend on my answer as legitimate legal or professional advice.

Congress enacted section 181 to promote film and television production in the United States. For a qualified film or television production commenced before January 1, 2008 (a “pre-amendment production”), section 181 permits an owner to elect to deduct production costs paid or incurred by that owner in the taxable year the costs are paid or incurred, in lieu of capitalizing the costs and recovering them through depreciation allowances, if the aggregate production costs do not exceed $15 million ($20 million if a significant amount of the aggregate production costs are paid or incurred in certain designated areas) for each qualifying production (the “aggregate production costs limit”). A film or television production (a “production”) is a qualified film or television production if 75 percent of the total compensation for the production is compensation for services performed in the United States by actors, directors, producers, and other production personnel.”

Note this sentence … “A film or television production (a “production”) is a qualified film or television production if 75 percent of the total compensation for the production is compensation for services performed in the United States by actors, directors, producers, and other production personnel.”

I’m sorry to say that it’s quite clear that the services must be performed in the United States to qualify.

Sorry about that. I sincerely hope that you find another way to get your project off the ground.

A student from New York had some very good questions about how to apply Section 181. I thought that I would share her questions, and my answers.

____________________________________________

QUESTION:

There are two things I would like to buildup my knowledge on:

I would definitely like to learn more details on how to actually “pass-through tax credits” to our investor group; as opposed to getting a check from the state and signing it over to our investor.

Also, getting the particulars on how Sec. 181 tax benefit actually gets to the investor; how do they claim it on their taxes.

Finally, if it falls within your purview … understanding the difference between:

Title Holder, LLC

Production Co. LLC

and which one, if at all, does the investor belong to?
__________________________________________________

ANSWER:1. State Refundable Tax Credit: What I have seen in the past is a “Notice of Direction of Payment” letter. It can be simple, or it can be complicated, but the concept is that the State Authority (which is issuing the tax credit) is directed to send the check directly to the investor. (I am attaching an example – it’s only for training purposes and may not work in your State, but it gives you an idea of how it works – I have sent it out once but the refundable check was still sent directly to the Production Company; however, the Bank was satisfied at the time).

The Q and A says:
“Q: What tax form do I need to fill out to get the incentive?
A: Currently, there is no specific form to fill out. The IRS temporary regulations require that you declare in a separate statement that you are electing to utilize Section 181. The legislative history also states that: “deducting qualifying costs on the appropriate tax return shall constitute a valid election.” Therefore, deducting the production costs (that would otherwise be capitalized) on your tax return will qualify as electing to take advantage of this incentive.”

3. Investor Ownership Under Section 181 – the investor belongs to the Production LLC. The investor under Section 181 needs to be an owner of the Production Company in the same proportion as his investment to total investment. It’s better stated in the link above as:
“In the case of a film co-produced by multiple investors, the deduction for qualifying expenditures must be allocated among the owners of the film in a manner that reasonably reflects each owner’s proportionate investment and economic interest in the film.”

There are 42 States currently offering some kind of film tax incentive. Different States have different types of incentives. The most common are Transferable Tax Credits. There are also Refundable Tax Credits, Grants and Rebates.

Producers don’t like to be merged with Accountants; however, a Producer who doesn’t understand the financing terminology of various States and Provinces film incentives is going to find himself/herself in the soup.

I’ve copy/pasted the examples, which are fairly easy to read. I hope this helps all you emerging producers to get your financing (if you’re new to this blog I have a couple of easy to read demonstrations of how Sec 181 works – dig around):

“§1.181-5 Examples.

The following examples illustrate the application of §§1.181-1 through 1.181-4:

Example 1. X, a corporation that uses an accrual method of accounting and files Federal income tax returns on a calendar-year basis, is a producer of films. X is the owner (within the meaning of §1.181-1(a)(2)) of film ABC. X incurs production costs in year 1, but does not commence principal photography for film ABC until year 2. In year 1, X reasonably expects, based on all of the facts and circumstances, that film ABC will be set for production and will be a qualified film or television production. Provided that X satisfies all other requirements of §§1.181-1 through 1.181-4 and §1.181-6, X may deduct in year 1 the production costs for film ABC that X incurred in year 1.

Example 2. The facts are the same as in Example 1. In year 2, X begins, but does not complete, principal photography for film ABC. Most of the scenes that X films in year 2 are shot outside the United States and, as of December 31, year 2, less than 75 percent of the total compensation paid for film ABC is qualified compensation. Nevertheless, X still reasonably expects, based on all of the facts and circumstances, that film ABC will be a qualified film or television production. Provided that X satisfies all other requirements of §§1.181-1 through 1.181-4 and §1.181-6, X may deduct in year 2 the production costs for film ABC that X incurred in year 2.

Example 3. The facts are the same as in Example 2. In year 3, X continues, but does not complete, production of film ABC. Due to changes in the expected production costs of film ABC, X no longer expects film ABC to qualify under section 181. X files a statement with its return for year 3 identifying the film and stating that X revokes its election under section 181. X includes in income in year 3 the deductions claimed in year 1 and in year 2 as provided for in §1.181-4(a)(3). X has successfully revoked its election pursuant to §1.181-2(d).”

The “Fiscal Cliff” bill passage which occurred in the early hours of New Years Day (2013) contains an extension of the IRS code Section 181 (Deductions for Qualified Film & Television Production Costs) through the end of 2013.

In an earlier blog I gave a very layman’s explanation of how Section 181 works for you as a producer trying to raise financing – i.e. pitching those who have the right kind of “passive income” to use Section 181 for a tax write off.

There’s a lot of excitement associated with the news about the extension of Section 181. Some if it is over-hype. It’s definitely a good thing, but you need to understand what an investor will get out of it in order to make a proper pitch. I wrote this as an entry level blog for someone who is just beginning to review how the US Federal Tax Incentive works (known by everyone as Section 181).

Here is a 15 point workflow of what I see as a way to pitch “Mr. Bucks”:

1. The person you need to pitch, let’s call this person Mr. Bucks, is someone with a lot of “Passive Income” (Passive Income is primarily rental income, not income earned from bonds, stocks, etc. – make sure that he has a good understanding of what passive income is and how it is defined under IRS rules). Worth pointing out, but necessary to our pitch, is that Mr. Bucks also has access to cash.

2. Mr. Bucks, let’s assume for now, is NOT actively involved in the development of the script and in the shooting of the film or television project.

3. You get Mr. Bucks to agree to wire $500,000 to the production bank account at key stages (say, $50,000 on the first day of prep, $300,000 on the first day of shooting, $100,000 when a rough cut is delivered and the final $50,000 when the final cut is ready for delivery to the film festival circuit).

4. During the Pitch you’ve pointed out to Mr. Bucks that you’re going to shoot the film in a defined low-income location, say Michigan, and that the production will take place entirely with in the USA (Note: to qualify under Section 181 at least 75% of the production must be in the USA).

5. The production will take place during the calendar year of 2011.

6. Mr. Bucks can now deduct the $500,000 from his “Passive Income”.

7. What does that mean for Mr. Bucks? Well, say he was taxed at 35%. So, he would have had to pay 35% of $500,000 = $175,000 to the IRS. Now he doesn’t. So, he spent $500,000 to save $175,000.

8. That means that Mr. Bucks is still out $325,000 that he’ll want back, with some kind of profit as well. For example, Mr. Bucks knows that if he just left his money in a safe interest earning investment he could make 2% without a worry. He’ll expect much more of a return for a higher risk investment like film.

9. So, how else can you sweeten your pitch to Mr. Bucks? Well, if you haven’t already factored into the budgeted costs the Michigan tax credit of 40% to 42%, you can promise that back to Mr. Bucks. For our purposes, let’s assume the total budget is $500,000 and that the Michigan tax credit is up for grabs. After going through the budget and carefully estimating the Michigan tax credit you come up with 40% of $400,000 = $160,000 that you can get back to Mr. Bucks.

10. Okay. Now you have saved Mr. Bucks $175,000 + $160,000 = $335,000. From Mr. Bucks point of view he is now spending $500,000 to get back $335,000.

11. Bottom line of your pitch is that you’re asking for $500,000 with a guaranteed reimbursement of $335,000 within a year or so, and a risk of $165,000.

12. Now comes the gi-normous pitch – why your film or television project will sell for more than a net return of $165,000.

13. Of course, in terms of the pitch you could throw out percentages like, “Mr. Bucks I can guarantee you a 67% recapture”.(Note: you don’t say “return” as that word means the amount he gets over and above the investment). This is huge in the film industry where the risk is usually so very high.

14. A major point I want to make is that you really need to tell Mr. Bucks that he needs to confirm all of this with his accountant or lawyer. If you get well into this only to find out that his income does NOT qualify as “Passive Income” there will be a lot of heartbreak.

15. A final point in the pitch is that if the investor can prove that he is ACTIVELY involved in the project, the investor can deduct the investment (i.e. the $500,000 in our example) from ALL income – not just from “Passive” income. Take care with this, because the definition of “ACTIVE” means that our Mr. Bucks must really be active in the development and production of the film or television production. I have heard some horror stories about this and unless Mr. Bucks is really part of the creative, production and delivery (i.e. showing up for work and can prove he is not just an angel investor) I wouldn’t even bring it up.

If you haven’t seen it before, here’s the IRS Bulletin that started it all – click here.

I’ve been on the road since Obama passed Section 181 (last Friday 12/21/10). I’m still having trouble adjusting to the fact that it all passed – I was so sure that there wasn’t a chance that I’ve not been following it very closely. Here is an excellent excerpt from The Filmmaker Magazine – see the full article here. Section 181 was just getting known amongst the Indie crowd when it expired. It’s taken so long to get back in place that many of us have stopped looking for it. Now it’s time to get those plans back in gear!

“The new Tax Bill was signed into law by President Obama earlier today. The tax law includes Section 744, which includes language that replaces IRC Section 181′s expiration date of December 31, 2009 with December 31, 2011.

Here is what this means:

1.) Any money spent on qualifying domestic film production* in 2010 now qualifies for the Section 181 tax write-off. 2.) Any money spent on qualifying domestic film production* in 2011 will also qualify for the Section 181 tax write-off. 3.) There is no gap in Section 181 protection…which means all the fear and worry that someone might have begun a project in 2009, somehow didn’t get the financing in place and investors invested in early 2010 can now breathe a sigh of relief.

*Please, remember that a “qualifying domestic film production” can be complicated and requires reading the original section of the IRC. My interpretation is if you shoot a movie, television episode, music video, short film, webisodes, etc. the investors will be able to deduct 100% of their investment in the same fiscal year. Traditionally, investors must deduct their investment over a three-year period. Why is this a big deal? For professional high net worth investors who need deductions in order to defer income Section 181 makes the film industry an excellent income deferral strategy. It makes our industry one of the most attractive for investors who are actively seeking legal income deferral strategies. Coupled with rebates from states it is possible for an investor to make a profit on a motion picture before the film has sold.

A lot of people will talk about how complicated Section 181 is. I personally find it easy to understand.

If I shoot 75% of a motion picture inside the US it qualifies.

If I shoot a television series then several seasons of episodes will qualify.

If I shoot a music video it qualifies.

If I shoot a documentary it qualifies.

If I shoot a TV commercial, pornographic film, corporate video or infomercial it won’t qualify.

Distribution expenses won’t qualify.

Development will, assuming it has been financed prior to the December 31st, 2011 deadline.

And, because of the grandfathering clause, if I begin production on a movie in 2010 or 2011 but do not complete it until after December 31, 2011 then all of it’s expenses will still qualify for Section 181 even if Section 181 is not renewed in 2012.

Those are the conclusions I have reached with my legal & tax consulting team. Please, consult with your own legal and tax experts. Be skeptical of my interpretations and this email. Verify the details with certified experts you trust.

However, the reason I’m writing this is because Section 181 has largely gone unused by smaller independent films and we’re the ones who can benefit from this most. The studios already use this to minimize risk and accelerate an exit for their investors. Now, every independent filmmaker needs to use this. This can be the turning point for independent film in America. This is how we can be self-reliant.”

Like this:

It’s not law yet, but the Senate passed a tax bill that includes an extension of Section 181. The bill retroactively reinstates (for one year) the ability to expense the first $15 million of production costs.

This is good news for filmmakers whose investors who want/need/expect the tax breaks of a same-year tax deduction.

This is very good news for filmmakers – if you would like more info on how the Fed Film Tax Credit works, send me an email and I’m happy to oblige.